Judges and commentators (myself included) routinely assert that an element of a claim under Sections 11, 12(a)(2) and 17(a) of the ’33 Act and Rule 10b-5 of the ’34 Act is a misstatement or omission of a material fact. However, the omission part of the element, with slight differences in phrasing, is actually an omission of “a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.� See Rule 10b-5(b). This phrase is a mouthful, hence my (and I assume others) use of “material omission� or the like for short. This shorthand, however, promotes the common misconception that these provisions create a duty to disclose all material information. This is not correct. They do not impose liability for omissions of material facts that are not necessary to make the statements made, in the light of the circumstances under which they were made, not misleading. Maybe this is just splitting hairs with respect to Sections 11 and 12(a)(2) given the litany of disclosure requirements for a public offering, but I don’t think it is hair splitting for 17(a) and 10b-5 in various contexts. Hence, I’m trying to come up with a new shorthand that reflects the subtle distinction. Any ideas?
Is the phrase "material omission" materially misleading?
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Of course it’s acceptable to omit material information in a 10-K or an S-1. The forms don’t require disclosure of all material information–they require disclosure of very specific information. For example, a company is only required to provide financial information within 135 days of filing. Clearly the company knows its results for some period within that time frame and that is clearly material. But there is no obligation to disclose that information–unless the company has made statements regarding trends that would be made misleading by the omitted financial data.
Mike: It is well established that there is no duty to disclose material facts absent a duty to speak. You may be correct that in the context of a registration statement, S-1 disclosure requirements coupled with Sections 11 and 12(a)(2) essentially create a duty to disclose all material facts (that’s why I referenced “splitting hairs�). I don’t think the same is necessarily true in the context of a 10-K (outside incorporation into a shelf registration). Regardless, Section 17(a) and Rule 10b-5 apply beyond both of these contexts. For example, a company can be liable under Rule 10b-5 for a press release that contains a misstatement of material fact. However, if a press release omits a material fact (say that the company has agreed to be acquired), that omission is generally not actionable under Rule 10b-5, even though it is material, unless the omission renders the press release misleading.
I’m not sure I agree with the premise of your comment. It is certainly true that not every disclosure that a firm makes triggers what I might call a “full” material disclosure requirement. But, going back to an issue Royce and I discussed on this blog earlier, if you are providing information about the firm as required in an S-1 or 10-K that is supposed to describe the business of the firm, is it ever acceptable to omit material information? My view is that the intent of the legislation in the context of an annual statement or an initial public offering is that the issuer must disclose all material information subject to competitive harm exemptions, whether or not this is how practitioners and the SEC interpret these provisions.
Royce: I see your point. Perhaps it’s not possible to capture the subtle distinctions through shorthand. However, I think Securities Lawyer’s suggestion of “misleading omission of a material fact” is at least more accurate than “material omission.” Maybe for Section 11 the way to go is “omission of a required material fact or misleading omission of a material fact.”
It’s going to be somewhat difficult to create a single term because there is a difference in the principles governing omissions in section 11. Section 11 gives rise to liability for omissions where the registration statement “omitted to state a material fact required to be stated therein or necessary to make the statments therein not misleading”. That is, if something material requried to be stated in a registration statement is omitted, the omission is actionable even if nothing else stated in the registration statement is made misleading by the omission.
Thus, if you wish to have a term specifying the nature of the reason the omission is actionable, you will need a term for omissions actionable under section 11 that is different from the term to describe omissions actionable under section 12.
When I was practicing (and I expect it is still the case), the 10b-5 closing “opinions” expressly reflected this distinction, so that the language of the assurance as to the registration statement (relevant to liability under section 11) was different from the language of the assurance as to the prospectus (relevant to liability under section 12).
My vote is for “misleading omission,” or the longer winded version “misleading omission of a material fact.” Materiality is so intertwined in federal securities laws that it’s essentially implied in the shorter phrase.
How about “cardinal omission”?
Webster’s dictionary explains that cardinal “suggests something on which an outcome turns or depends.” Your observation accurately notes that the real meaning of material omission in this context is the undisclosed fact would have made the statement not misleading; i.e., without the fact, the statement is misleading – with it, it’s not. Therefore, the outcome depends on the omission.
What do you think?